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Macroeconomic influences on optimal asset allocation
Author(s) -
Flavin T.J.,
Wickens M.R.
Publication year - 2002
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1016/s1058-3300(02)00072-1
Subject(s) - economics , portfolio , asset allocation , inflation (cosmology) , econometrics , autoregressive conditional heteroskedasticity , asset (computer security) , variable (mathematics) , financial economics , volatility (finance) , computer science , mathematics , mathematical analysis , physics , computer security , theoretical physics
We develop a tactical asset allocation strategy that incorporates the effects of macroeconomic variables. The joint distribution of financial asset returns and the macroeconomic variables is modelled using a VAR with a multivariate GARCH (M‐GARCH) error structure. As a result, the portfolio frontier is time varying and subject to contagion from the macroeconomic variable. Optimal asset allocation requires that this be taken into account. We illustrate how to do this using three risky UK assets and inflation as a macroeconomic factor. Taking account of inflation generates portfolio frontiers that lie closer to the origin and offers investors superior risk–return combinations.